Large and small businesses alike often find it most efficient to hire employees (W-2 workers) for some roles and tasks and independent contractors (1099 workers) for others. Understanding the differences between 1099 vs W-2 workers is important, as misclassifying employees as contractors can lead to thousands in fees and penalties.
1099 vs W-2 Quick Comparison | ||
|---|---|---|
Contractor | Employee | |
What Tax Forms am I Required to Use? | ||
Paid Hourly or Salary? | Hourly or flat rate; never salary | Hourly or salary |
Do I Pay Payroll Taxes on Their Earnings? | No | Yes |
Can I Fire Them Easily? | Yes, just be aware of contract stipulations and dates (don’t say you’re firing the worker—you’re terminating the contract) | Yes, at-will employment reigns*, and you can also easily fire for performance or behavior (if documented) |
Full- or Part time? | Usually part time, on-demand, or by project | Usually a consistent full-time or part-time schedule |
*All states recognize at-will employment on a contractual level, except Montana. If you terminate an employee in Montana who has completed your company’s established probationary period, you need to have good cause for the termination.
As your business expands and you make decisions about whether to hire full-time (or part-time) employees or independent contractors, consider these five areas in which you will see differences.
1. Payroll Taxes
When you hire employees, you’re responsible for doing payroll, which includes withholding payroll taxes from their paychecks—in addition to paying taxes on their earnings out of your business funds. Meanwhile, handling independent contractors’ payroll involves paying them their total earnings for the period, though you won’t have to withhold taxes.
Example: You have an employee who earns $1,200 for the week. Since they’re not a contractor, the amount on their paycheck will be less than $1,200—because you’ll have to subtract the total taxes you’re required to withhold to determine how much to pay them. If they were an independent contractor, however, they would receive a total of $1,200. Contractors are responsible for squaring up their tax bills with the IRS and state and local tax agencies on their own.
If you need help paying both contractors and employees, consider using a payroll software provider like Gusto. It can handle both your traditional W-2 employees and 1099 contractors (including international contractors), all from its affordable platform—which is why it’s our best overall payroll software and one of our recommended payroll software for paying contractors.
Learn more about it in our Gusto review. You can also visit its website and get one month free when you run your first payroll. Offer will be applied to your Gusto invoice(s) while all applicable terms and conditions are met or fulfilled.
2. Tax Forms
Although employers manage payroll tax payments for their employees, employees are still responsible for ensuring they don’t owe any additional taxes (or aren’t entitled to a refund due to overpayment). In this sense, both employees and contractors have at least some responsibility to settle any outstanding bills with tax agencies.
Employers help facilitate this by issuing year-end tax forms (1099 and W-2) that show the total amount each worker earned for the year.
- Form 1099-NEC: Contractors receive Form 1099-NEC, which shows the worker’s name, Social Security number, address, and total earnings for the year. Learn how to fill out and prepare this with our guide on the 1099-NEC form.
- Form W-2: Employees receive Form W-2, which shows basic information, in addition to total taxes and other deductions withheld. Learn how to fill out a W-2 form.
3. Federal Labor Law Protection
Employees and contractors are treated differently when it comes to federal labor law protections. US labor laws protect employees from being paid less than the federal minimum wage (currently $7.25 an hour), ensure that eligible employees (typically hourly workers) receive overtime for hours worked over 40 in a week, and set strict standards for when minors can work and the type of work they’re allowed to perform. Learn more about the different types of employees and what that entails in our guide.
If any HR and payroll compliance rules are broken, employers can be sued and face litigation. Contractors, however, aren’t privy to these protections and don’t have any recourse unless it’s explicitly stated in their contracts. Having an independent contractor agreement in place will help protect you.
Note: With the rise of freelance work, some states and cities have implemented independent contractor worker protections. For example, New York City, Los Angeles, Seattle, and others have laws in place requiring employers to use written contracts with freelancers and have increased penalties for companies that violate these contracts.
4. Terminating Contractors vs Employees
Another factor to keep in mind is the at-will employment doctrine, which gives you the right to terminate employees at any time without notice or cause (as long as it doesn’t violate any federal or state labor laws). However, if you need to let a contractor go, it may not be as easy; you’ll have to abide by the terms of the contract you signed at the beginning of your relationship with them.
- With a contractor, you need to pay attention to the terms of the contract you are signing and your right to terminate it. Some contracts are hard to break, so keep this in mind when negotiating. We recommend at least a 5- to 10-day notice of termination from either party.
- On the other hand, you can terminate employment at any time. To protect yourself, it’s best to include the at-will employment language in all employment agreements and employee handbooks. That said, you need to comply with all federal and state labor laws, which are meant to provide boundaries for employee dismissal. Remember that Montana is not an at-will state, so you’ll need good cause for terminating an employee there.
5. Paychecks & Benefits
The last major notable difference between 1099 vs W-2 workers is how they are paid and the benefits to which they are entitled.
- Contractors aren’t as likely to receive consistent pay—you can pay them via monthly invoices or on a per-project basis.
- Employees may be either salaried or hourly and full time or part time with a consistent schedule (generally paid weekly, every other week, twice monthly, or less commonly, monthly). Certain types of benefits, like health insurance, flexible spending accounts, 401(k), and so forth are reserved for employees.
Questions to Ask When Classifying Workers
According to the IRS, there are three main questions to ask yourself when classifying 1099 vs W-2 team members at your business. Note that, in general, only one of the questions has to fit the bill for a worker to be considered an employee.
- Behavioral question: Does the company control or have the right to control what the worker does and how the worker does their job?
If the answer is “yes,” the worker is likely an employee. If the worker is free to manage their schedule and work process, then they are more likely a contractor.
- Financial question: Are the business aspects of the worker’s job controlled by the employer? (These include how a worker is paid, whether expenses are reimbursed, and who provides tools/supplies.)
If the company controls how the worker is paid and pays for expenses and supplies, then they’re likely an employee. However, if the worker has to send an invoice to get paid and/or cover their expenses, they are more likely a contractor.
- Working relationship question: Are there written employment contracts (versus projects or an independent contractor agreement) or employee-type benefits (like health insurance and vacation pay)? Will the working relationship continue for the foreseeable future if the work is done correctly, and is the work performed a key aspect of the business?
If the company provides employee benefits and believes the worker is there for the long term, they are likely an employee.
Pros & Cons for 1099 vs W-2 Workers
1099 vs W-2 Workers Frequently Asked Questions (FAQs)
Expand the sections below for answers to some of your most common questions related to hiring contractors vs employees.
What is a W-2 and what is a 1099?
A W-2 form is an annual wage and tax statement that employers must provide to all employees. It outlines the amount of taxes withheld from each employee’s pay for the year, along with other financial details. The employer also sends a copy to the IRS. W-2 employees have taxes automatically deducted from their paychecks, and they may be eligible for employer benefits.
A 1099 form is issued to independent contractors, freelancers, and self-employed individuals who have performed services for a company—but, crucially, they are not employees of the company. This form reports the amount of money the contractor made from a particular business during the tax year. Unlike W-2 employees, 1099 workers pay their own taxes.
What are some examples of W-2 workers vs 1099 workers?
W-2 workers can be found in every industry. They could be office workers, teachers, construction workers, and more. Essentially, if someone is an employee of a company and receives regular wages or salary, they are a W-2 worker.
1099 workers can also be found in various industries. They often handle roles such as consultants, writers, graphic designers, rideshare drivers, and real estate agents. These individuals typically have a specialized set of skills and are partnered with on a per-project or non-permanent basis. It’s always advisable to use an independent contractor agreement.
What are the penalties for misclassifying a worker?
Misclassifying a worker can lead to serious penalties. If the IRS determines that an employee has been incorrectly classified as an independent contractor, they can impose fines ranging from $50 for each W-2 form that wasn’t filed up to 3% of all the wages paid, along with 100% of the FICA taxes for both the employee and the employer.
In cases where the IRS finds that the employer intentionally disregarded the rules for proper employee classification, the penalties are even steeper—up to $1,000 per misclassified worker and one year in prison. The employer could also face additional fines for failing to provide employee benefits like health insurance, retirement, unemployment, and workers’ compensation.
Which type of worker should I hire?
The type of worker you should hire depends on your business needs. If you require long-term, consistent work and want control over how the work is done, hiring a W-2 employee may be the best choice. You’ll need to account for benefits and tax withholdings, but you’ll have greater oversight and consistency.
If you have a specific project or short-term need, or if you need specialized skills that your current team doesn’t possess, partnering with a 1099 worker can be advantageous. You won’t need to provide benefits or withhold taxes, but you will have less control over the work process.
It’s important to note that the decision isn’t just about business needs or costs. Properly classifying workers is a legal requirement, and it’s crucial to understand the differences to avoid penalties. When in doubt, consult with a legal or tax professional.
Bottom Line
When it comes to hiring new workers, business owners can choose between independent contractors and employees (1099 vs W-2). Contractors have more independence in how they conduct their work but aren’t protected by labor laws such as minimum wage. Employees, on the other hand, provide more job stability for promoting and retaining employees.
Both W-2 and 1099 workers can be valuable assets to a business as they perform the work you need to run the company. If you need a strong sense of control over the work and the worker’s time, you’re better off hiring an employee. Avoid falling into the trap of calling an employee a contractor, because that can come back to haunt you; taxes can add up quickly, especially if you have to add fines and penalties.
